Sunday, November 7, 2010

After election, market faces rare trifecta

NEW YORK  Next year will be a year unlike any other for the stock market.The Republican takeover of the House on Tuesday means Wall Street will be contending with three situations in 2011 that drive stock prices:

• The year before a president faces re-election.

• The year after a president has lost control of Congress.

• The second year of a fragile economic expansion.

The market often behaves a certain way in each of those situations, but history isn't helpful now because investors have never faced this trifecta. What's clear is that what happens in Washington will be watched even more closely by investors next year.

"This election is more important than the average one because of all of the economic and policy issues that remain uncertain," said Robert Doll, the chief investment strategist at BlackRock, an investing firm with $3.4 trillion in assets under management.

Any mishandling of the economy by politicians will mean that "the fragile economic recovery we have is going to be hit over the head, and we would have to think about a double-dip recession all over again," Doll said.

On Day One after the mid-term elections, the Dow went up. The closely watched index closed at 11,215.13 on Wednesday, a high for the year after the Federal Reserve announced that it plans to buy $600 billion in Treasurys to stimulate the economy.

Looking ahead, here are three situations coinciding next year and how they could affect the stock market in the long run:

THE YEAR BEFORE A PRESIDENT RUNS FOR ELECTION:

Since 1945, the Dow Jones industrial average has gained an average of 19 percent the year before a sitting president runs. That's more than double the 7.9 percent average annual gain during the same period. If you take out the 10 years when the president was running, the average gain drops to only 5.8 percent.

No one has been able to prove why this happens. One theory is that the president pushes through politically popular spending measures to help his re-election. But that doesn't explain why the market also tends to rise in the third year of a president's second term. The Dow rose 25.2 percent, for example, in 1999, the third year of President Bill Clinton's second term. Since 1902 the Dow has gained, on average, 13.7 percent in the third year of a president's first term and 10.9 percent in the third year of a president's second term.